The PRC State Administration of Taxation has launched a campaign targeting the China representative offices of foreign companies. There are an estimated 7,000 such offices in China, and the State Administration of Taxation wants to ensure that they have registered for tax and are reporting any income in accordance with the relevant regulations.
At the same time, clarification has been issued concerning a number of activities for which representative offices will be subject to tax in China.
Widespread tax evasion
Spurring this initiative are dismal fiscal figures, offered by the central tax authorities as proof that many representative offices continue to evade the tax man. Representative offices must register with and report to tax authorities, even if they declare no taxable income. Yet the authorities claim that in Beijing, for example, where there are 4,400 representative offices, almost half have failed to register. And while officials have declined to give concrete figures, they note that increased tax revenues contributed by representative offices have "hardly reflected" the seven-fold growth in the number of representative offices since 1985.
These deficits reflect a broader picture, highlighted in a recent report from Chinese academics, who point to a halving in the central government's budgetary revenue-to-GDP ratio. From a 1980 high point of 23.1 per cent, the ratio fell to 10.7 percent in 1995; the ratio for a developing country should be around 30 per cent. The effect of that drop has been an increasing reliance by central government on domestic debt, and a squeeze on funds available for infrastructure and other pillars of the domestic economy, such as education and health.
The central government is taking both administrative and punitive steps to control the sources of tax revenues. These have been mandated by two circulars jointly issued by the State Council and the State Administration of Taxation.
First, the Notice on Increasing Coordination of Tax Collection from Foreign Investment Enterprises orders state and local tax bureaux to establish "information exchange systems". The different bureaux must notify each other "promptly" of changes in their tax records ? the notice envisages this being done by exchanging reports on standardised forms.
The notice, as its title implies, covers a variety of foreign enterprises in China. With regard to representative offices, the notice makes it clear that their tax status is a matter of concern at both state and local levels. Representative offices can pay tax on the basis of their actual revenue and expenses, or on deemed profits, or by applying the cost-plus method. State and. local bureaux are required to liaise with one another in determining the tax basis of every representative office and to ensure that, whichever makes the final determination, the other is informed of the results.
The second circular, entitled Notice on Issues Related to Increasing Management of Tax Collection among Foreign Investment Resident Representative Offices, requires tax bureaux to conduct a nation-wide audit into tax registration and reporting by representative offices. The audit will be carried out in coordination with reporting from hotels and other places where representative offices are commonly located. Tax officials have stated that they intend to publicise a list of the names of the worst tax offenders and to shut down the offices of some unlicensed resident representative offices.
Widening the tax net
The second circular also seeks to clarify which activities undertaken by representative offices are tax-exempt and which are not.
Originally, representative offices in China, including those clearly earning fee income from third parties, were not subject to tax. Gradually, the broad principle evolved that resident representative offices could engage in non-direct business activities within China for foreign enterprises and not be taxed; but that activities outside that scope would be considered for tax purposes to be "direct business activities" ? and therefore subject to taxation. By limiting the foreign enterprises which could be represented without paying tax, and by narrowing the scope of non-direct business activities, the taxation authorities have, with a few exceptions, expanded the basis for taxing representative offices.
The Increasing Management of Tax Collection Notice is not an exception to this trend. It lists a number of activities which will be considered "direct business activities" for tax purposes. They include:
* activities undertaken by the representative office on behalf of its head office, where the head office is a trading company
* service activities undertaken by representative offices of foreign commercial, legal, accounting or tax service businesses
* service activities undertaken by the representative office on behalf of its parent company, where the parent is a foreign holding company or company limited by shares
* services by the representative office of a bank or other financial institution, in providing investment information
* services provided by a representative office whose parent is an overseas travel agency ? these activities may include undertaking visa matters; receiving fees; acting as a ticketing agent; providing tour guides or arranging room and board.
To comply with the relevant tax regulations, tax-exempt representative offices should ensure that they are presently engaged in non-taxable activities. They should also examine the tax implications of any new activities undertaken since their establishment, and determine whether or not those are tax-exempt. Representative offices whose tax status has not yet been determined, or whose tax registration has not been finalised, can expect a discussion of these issues with the state and local tax bureaux when they are next audited.
Freshfields is an international law firm. Most of its offices throughout Asia, Europe and North America include China specialists. For further details, contact Matthew Cosans through their offices in Hong Kong (tel: +852 2846 3400) or Beijing (tel: +8610 6465 4795).